Opinion: Your state’s finances might look like Puerto Rico’s 10 years from now

Hurricane-struck areas will fare the worst, while underfunded pensions all over the U.S. endanger local governments

Associated Press

An empty field north of Detroit's downtown. The city filed for Chapter 9 bankruptcy in July 2013.

By

JohnMauldin

Investment strategist

This is the first time on record that two Category 4 hurricanes have struck the U.S. mainland in the same year.

Worse, Harvey and Irma landed on some of our most valuable and vulnerable coastal areas. So now, besides all the problems, the U.S. economy has to absorb the cleanup and rebuilding costs for large parts of Texas and Florida, as well as our Puerto Rico and U.S. Virgin Islands territories.

Now then, people who live in coastal areas know full well that hurricanes happen. They know the risk, just not which hurricane season might launch a devastating storm in their direction.

The primary asset of a city, county or state is future tax revenue from households and businesses. Taxpayers can move, leaving the municipality high and dry.

Yet, the assumptions of what constitutes adequate preparedness were largely flawed.

The Commonwealth was already in deep debt before Irma blew in — $123 billion worth of it. There’s simply no way the island can repay such a massive debt.

Now Puerto Rico is in a new form of bankruptcy that Congress authorized last year. Court proceedings will probably drag on for years, but the final outcome isn’t in doubt. Creditors will get some scraps — at best, perhaps 30 cents on the dollar, my sources say — and then move on.

“That’s just Puerto Rico,” you may say if you’re a U.S. citizen in one of the 50 states. Be very careful. Your state is probably not so much better off. In 10 years, your state may well be in the same place where Puerto Rico is now. I’d say the odds are better than even.

Are your elected leaders doing anything about this huge issue, or even talking about it? Probably not.

As it stands now, states can’t declare bankruptcy in federal courts. Letting them do so would raise thorny constitutional issues. So maybe we’ll have to call it something else, but it’s going to end the same way. Your state’s public-sector retirees will not get what they were promised, and they won’t take the outcome kindly.

The most indebted states will be abandoned

Public sector bankruptcy is vastly different from corporate bankruptcy.

Say a corporation goes bankrupt. A court will take all its assets and decide how to divvy them up. The assets are easy to identify: buildings, land, intellectual property, cash, etc.

Not so in a public bankruptcy. The primary asset of a city, county, or state is future tax revenue from households and businesses within its boundaries. The taxpayers can walk away.

Even without moving, they can bypass sales taxes by shopping elsewhere. If property taxes are too high, they can sell and move. When they take a loss on the sale, the new owner will have established a property value that yields the city far less revenue than it used to receive.

Cities and states don’t have the ability to shed their pension liabilities. They are stuck with them, even as population and property values change.

We may soon see an example of this in Houston.

What about those thousands of flooded homes in and around Houston; how much are they worth? Right now, I’d say their value is zero in many cases. Maybe they will have some value if it’s possible to rebuild, but at the very least they ought to receive a sharp discount from the tax collector this year.

Here in Dallas I pay about 2.7% in property taxes. When I bought my home over four years ago, I checked our local pension and was told we were 100% funded. I even mentioned in my letter that I was rather surprised. Turns out they lied.

Now, realistic assessments suggest they will have to double the municipal tax rate (yes, I said double) to be able to fund fire and police pension funds. Not a terribly popular thing to do.

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John
Mauldin

John Mauldin is chairman of Mauldin Economics, president of Mauldin Solutions LLC, an investment-advisory firm, and a registered principal of Mauldin Securities LLC. He is the publisher of "Thoughts From the Frontline," an investment newsletter. Mauldin lives in Dallas.

John
Mauldin

John Mauldin is chairman of Mauldin Economics, president of Mauldin Solutions LLC, an investment-advisory firm, and a registered principal of Mauldin Securities LLC. He is the publisher of "Thoughts From the Frontline," an investment newsletter. Mauldin lives in Dallas.

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